A trio of congressional Democrats have introduced a bill that would provide tax relief to homeowners who were wrongly foreclosed upon and receive money from the recent nationwide mortgage foreclosure settlement.

State attorneys general across the country successfully sued five of the major banks that had been accused of using so-called “robosigning” and other dubious methods to expedite illegal foreclosures. The $25 billion settlement, which was announced last month, represents the largest financial recovery obtained by the states’ attorneys general since the 1998 Master Tobacco Settlement, was reached with Bank of America, J.P. Morgan Chase, Wells Fargo, Citigroup and Ally Financial.  It will allow hundreds of thousands of distressed homeowners to stay in their homes through enhanced loan modifications and principal reduction, and it will also provide payments to victims of unfair foreclosure practices.

However, under current law, those settlement payments would subject the homeowners and servicemembers who receive them to additional tax burdens.  Homeowners receiving relief in the form of mortgage debt forgiveness and direct cash payments for wrongful foreclosure could be subject to federal income tax.  In addition, extra taxes would be owed on the payments made to servicemembers who were wrongfully foreclosed on while deployed overseas.

Representatives Jim McDermott, D-Wash., John Larson, D-Conn., and Shelley Berkley, D-Nev., introduced the Homeowners Tax Fairness Act on Wednesday to protect homeowners and servicemembers who were wrongly foreclosed on and entitled to relief under the historic national mortgage settlement from additional tax burdens.

The bill would extend the exclusion for debt forgiveness on a primary residence throughout the term of the settlement agreement, and exclude the relief payments from income for homeowners and servicemembers.

“I applaud the work of the state attorneys general in brokering this settlement to provide needed relief to America’s homeowners and servicemembers,” McDermott said in a statement.  “This level of consensus is rare, and speaks volumes to how important this relief is. Now it’s our turn to ensure that every bit of negotiated relief goes to the people who need it the most. Collecting federal income tax on relief intended for struggling homeowners is not only bad policy, but is simply wrong.”

The McDermott-Larson-Berkley bill also considers the particularly egregious actions taken by the five largest banks in violation of the Servicemembers Civil Relief Act. Over the past three years, the five largest servicers violated the law and wrongfully foreclosed or overcharged mortgage interest on servicemembers, many of whom were deployed overseas in combat zones. The Homeowners Tax Fairness Act not only excludes this relief from income to servicemembers, but denies these banks the ability to deduct these payments from their federal income taxes.

Reps. McDermott, Larson and Berkley—each of whom is a member of the Ways and Means Committee, the U.S. House of Representatives’ tax-writing panel—introduced the bill with the support of every Democratic member of the Ways and Means Committee.

Specifically, the legislation would extend the exclusion from income for debt forgiven on a primary residence, originally enacted in 2007 for the three year period anticipated by the settlement agreement. The bill would also extend the deduction for mortgage insurance for three years. It would also exclude from income the direct cash payments for wrongful foreclosure. The bill would also exclude from income the payments to servicemembers wrongfully foreclosed on or overcharged mortgage interest in violation of the Servicemembers Civil Relief Act; and deny the deduction to banks for relief payments made in violation of the Servicemembers Civil Relief Act.

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